Finances in Chapter 11 -
When Can Cash Collateral Be Used?
A debtor is not permitted to use cash collateral absent consent of the lender and a court order approving same, and is required to sequester it in a separate account. In the usual situation, the debtor's attorney will negotiate with the attorney for the secured creditor, and come up with a stipulation for use of cash collateral. Typically, the debtor will be authorized to use the cash collateral for needed payments, such as maintenance, taxes, insurance, property management, taxes, utilities, etc., and a management fee, with the balance being remitted to the secured creditor.
Can the Order Permit Use of Cash Collateral?
If the lender will not consent to use of cash collateral, then the debtor needs to seek a court order giving him permission to use it. The debtor will need to show to the court that the interests of the lender are "adequately protected".
Under Section 361 of the Bankruptcy Code, this "adequate protection" can be provided in several different ways. It can come in the form of periodic cash payments to the lender, especially where there is a decrease in the value of the collateral; replacement or additional liens; or in any other way which provides the creditor with what is known in bankruptcy jargon as "the indubitable equivalent" of the lender's interest in the property.
What Happens if Cash Collateral is Misused?
If cash collateral is used without consent of the lender or a court order allowing such use, the court will often find it to be grounds for granting relief from stay to the lender, appointing a trustee, or converting the case to Chapter 7. The courts take the use/misuse of cash collateral very seriously, and well they should, since once it's gone, it is not likely to return.
Sometimes, a DIP
needs additional financing during Chapter 11 to meet ongoing operating
expenses. Since he is in bankruptcy, the normal lending channels are
not available. Section 364 of the Bankruptcy Code allows a DIP, subject
to court approval, to borrow money (obtain credit). The borrowing
can be done on an unsecured, secured, or priority basis. There are
some niche lenders who specialize in "DIP financing". Under
these loan agreements, such a lender can be given a "super-priority"
lien on property of the estate, putting it ahead of unsecured creditors
and even existing liens. The DIP will need to demonstrate to the court
the urgent need of the funding, and that the interests of the existing
creditors will continue to be adequately protected.
Written by Henry Rendler
Written by Henry Rendler
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